This calculator helps you estimate the intrinsic value of a stock using the Dividend Discount Model (DDM).
Enter values to see the result here.
Understanding the Stock Price Formula (Dividend Discount Model)
The intrinsic value of a stock represents the true worth of a company's stock, independent of its current market price. One of the most widely used methods to estimate this intrinsic value is the Dividend Discount Model (DDM). The DDM is based on the principle that the value of a stock is the present value of all the future dividends an investor expects to receive from that stock.
The Gordon Growth Model (A Common DDM Variant)
A popular and simplified version of the DDM is the Gordon Growth Model, which is suitable for stocks that are expected to pay dividends that grow at a constant rate indefinitely. The formula is:
P0 = D1 / (k – g)
Where:
P0 = The intrinsic value of the stock today (what you're calculating).
D1 = The expected dividend per share next year. This is the dividend expected to be paid out over the next twelve months.
k = The required rate of return. This is the minimum rate of return an investor expects to earn on their investment, considering the risk involved. It's often based on the company's cost of equity.
g = The constant dividend growth rate. This is the rate at which the dividends are expected to grow year after year, in perpetuity.
Key Assumptions and Limitations
The Gordon Growth Model relies on several key assumptions:
Dividends are paid and grow at a constant rate (g) forever.
The growth rate (g) must be less than the required rate of return (k). If g is greater than or equal to k, the formula yields a negative or infinite stock price, which is nonsensical in practice.
The model is best suited for mature, stable companies that pay regular dividends and have predictable growth.
It doesn't account for other factors that can influence stock price, such as share buybacks, asset values, or changes in market sentiment.
When to Use This Calculator
This calculator is useful for:
Fundamental Investors: To estimate if a stock is undervalued or overvalued by comparing the calculated intrinsic value to the current market price.
Long-Term Investors: For companies with a history of stable dividend payments and predictable growth.
Educational Purposes: To understand the relationship between dividends, growth rates, and the expected return on a stock.
Remember, this model provides an estimate and should be used in conjunction with other valuation methods and thorough research.
Example Calculation:
Let's say a company is expected to pay a dividend of $2.50 per share next year (D1 = $2.50). Investors require a 10% rate of return (k = 0.10), and the dividends are expected to grow at a constant rate of 5% per year (g = 0.05).
This suggests the intrinsic value of the stock is $50.00.
function calculateStockPrice() {
var dividendPerShare = parseFloat(document.getElementById("dividendPerShare").value);
var requiredRateOfReturn = parseFloat(document.getElementById("requiredRateOfReturn").value);
var dividendGrowthRate = parseFloat(document.getElementById("dividendGrowthRate").value);
var resultElement = document.getElementById("result");
// Input validation
if (isNaN(dividendPerShare) || isNaN(requiredRateOfReturn) || isNaN(dividendGrowthRate)) {
resultElement.innerHTML = "Please enter valid numbers for all fields.";
return;
}
if (requiredRateOfReturn <= dividendGrowthRate) {
resultElement.innerHTML = "Error: Required Rate of Return (k) must be greater than Dividend Growth Rate (g).";
return;
}
if (dividendPerShare < 0 || requiredRateOfReturn < 0 || dividendGrowthRate < 0) {
resultElement.innerHTML = "Values cannot be negative.";
return;
}
var intrinsicValue = dividendPerShare / (requiredRateOfReturn – dividendGrowthRate);
// Format the result to two decimal places
var formattedValue = intrinsicValue.toFixed(2);
resultElement.innerHTML = "Estimated Intrinsic Value: $" + formattedValue + "";
}